Picture this: You just bought your first rental property for $400,000. After the mortgage payment, taxes, insurance, and repairs, you’re barely breaking even each month. Then tax season rolls around, and your accountant shows you something interesting—even though you didn’t lose any actual money, the IRS says your rental “lost” $14,545 on paper. That loss reduces your taxable income, potentially saving you thousands in taxes.
Welcome to depreciation—the rental property owner’s secret weapon for turning breakeven deals into tax-advantaged investments.
How depreciation actually works
The IRS recognizes that buildings wear out over time, so they let you deduct a portion of your property’s cost each year. For residential rentals, you spread this deduction over 27.5 years using something called “straight-line depreciation.”
Here’s the catch: you can only depreciate the building, not the land. So if you bought that $400,000 property, you need to figure out how much was building versus land. Let’s say an appraisal shows the building is worth $300,000 and the land is worth $100,000.
Your annual depreciation would be: $300,000 ÷ 27.5 years = $10,909 per year.
That’s $10,909 you can deduct from your rental income every single year, without spending a dime.
A real example that shows the power
Let’s follow Sarah, who bought a duplex for $500,000 ($375,000 building, $125,000 land). Here’s her first year:
- Rental income: $36,000
- Expenses: $35,000 (mortgage interest, taxes, insurance, repairs)
- Cash flow: Around $1,000 (barely positive)
- Depreciation deduction: $375,000 ÷ 27.5 = $13,636
On her tax return:
- Rental income: $36,000
- Total deductions: $35,000 + $13,636 = $48,636
- Taxable rental income: -$12,636 (a loss!)
Even though Sarah made $1,000 in cash, she shows a $12,636 tax loss. If she’s in the 22% tax bracket, this could save her $2,780 in taxes—turning her $1,000 cash flow into $3,780 of total benefit.
See Sarah’s numbers in action: View the live calculation
The “use it or lose it” rule
Here’s something most investors don’t realize: the IRS reduces your property’s “basis” (what you originally paid) by depreciation each year, whether you claim it or not. This means if you don’t take the deduction, you’re giving up tax savings now but still paying the penalty later when you sell.
It’s like leaving money on the table twice—first by not reducing your current taxes, then by still owing “depreciation recapture” tax when you sell.
What happens when you sell?
When you eventually sell the property, you’ll pay “depreciation recapture” tax on all the depreciation you claimed (or should have claimed). This is currently taxed at up to 25%, compared to long-term capital gains rates that can be 0%, 15%, or 20%.
But here’s the key insight: you’re essentially getting an interest-free loan from the IRS. You save taxes today and pay them back later, often many years later. The time value of money makes this a great deal.
Three ways smart investors handle the recapture
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Hold forever: If you never sell, you never pay recapture. Many investors build rental portfolios they pass to heirs, who get a “stepped-up basis” that can eliminate the recapture entirely.
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1031 exchanges: Trade up to bigger properties and defer both capital gains and depreciation recapture indefinitely.
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Accept the math: Even paying recapture later, the years of tax savings and cash flow often make the deal profitable.
Getting started: what you need to know
Split your purchase price correctly: Get an appraisal or use your county’s assessed values to determine the building-to-land ratio. This becomes your depreciation basis.
Start when you’re ready to rent: Depreciation begins when the property is “placed in service”—ready and available for tenants, not necessarily when you buy it.
Track improvements separately: A new roof or HVAC system gets depreciated over time. Regular repairs like fixing a leaky faucet are deducted immediately.
See how it works with your numbers
Want to see how depreciation impacts your specific deal? Our calculator shows both the annual tax benefits and the long-term recapture implications:
Model your property: Investment Property Calculator - includes depreciation in the cash flow analysis
Important: This isn’t tax advice. Tax laws are complex and change over time. Always consult with a qualified CPA or tax professional who can review your specific situation and ensure you’re following current regulations.
The bottom line? Depreciation can transform mediocre rental deals into compelling investments. Don’t leave this powerful tool unused.